The name Warren Buffett is virtually synonymous with “expert investor.” And whether you’re a fan of Buffett’s past political proclamations about how the rich aren’t paying enough taxes (I certainly am not), I do admit that the “Oracle of Omaha” usually offers up some great homespun wisdom about how to invest your money (not just trade for the quick score). And apparently, the man likes index funds.
Warren Buffett recently was interviewed on CNBC, and the topic of the 2008 financial crisis came up. Buffett told CNBC’s Joe Kernen that he had read a preliminary version of former Treasury Secretary Tim Geithner’s soon-to-be-published memoir, and that Buffett’s previous characterization of the crisis as an “economic Pearl Harbor” was an understatement. Yet in the spirit of optimism, Buffett said the recovery from the hit the U.S. took was telling, and that he believes “this country will come through anything.”
So, what does an investor do who is truly optimistic about the country’s resilience?
Simple: You get your money into the market in some of the best index funds out there, then sit back and let time grow your wealth.
Now, if you think this is too simplistic, think again. Writing in his Berkshire Hathaway (BRK.B) annual shareholder letter, Warren Buffett recommended non-professional investors should “own a cross-section of businesses that in aggregate are bound to do well. A low-cost S&P 500 index fund will achieve this goal.”
Buffett went even further with this simple advice, writing that the advice for the trustee of his estate “could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.)”
With Warren Buffett’s advice in mind, I decided to put my own spin on his homespun wisdom by taking a look at the five best index funds for the optimistic, long-term investor.
Best Index Funds #1: Vanguard S&P 500 ETF (VOO)
1-Year Performance: 20.3%
3-Year Performance: 14.84% (annualized)
Expense Ratio: 0.05%
If you want to follow Warren Buffett’s recommendations, then 90% of your money should be in the Vanguard S&P 500 ETF (VOO). This exchange-traded fund is designed to mirror the performance of the S&P 500 Index, so if you are long-term bullish on the broad measure of the large-cap, domestic equity market, then one of the best index funds you can own is VOO.
Because VOO just reflects the S&P 500, top holdings are the same, too. That puts Apple (AAPL), Exxon Mobil (XOM), Google (GOOG), Microsoft (MSFT) and Johnson & Johnson (JNJ) at the top.
And at an expense ratio of just 0.05%, you also fulfill the Warren Buffett criteria of “low cost.” It doesn’t get much lower than that — period.
Best Index Funds #2: Vanguard Total Stock Market Index (VTI)
1-Year Performance: 22.4%
5-Year Performance: 22.37% (annualized)
Expense Ratio: 0.05%
You’ll note that Vanguard funds are going to become something of a theme here. They’re not the king of low costs for nothing.
If you want to broaden your horizons in terms of index fund exposure, then check out the Vanguard Total Stock Market Index (VTI). This ETF is pegged to the MSCI US Broad Market Index, and by “broad,” that means exposure to about 99.5% of the total market capitalization of all common stocks traded on the NYSE, NYSEMKT and Nasdaq exchanges. However, on the top end, VTI doesn’t differ much from the VOO, and in fact the top 10 holdings are identical.
VTI currently holds more than 3,600 stocks and charges just 0.05% for doing so. That makes this Vanguard fund a fantastic way to essentially buy the entire market.
Best Index Funds #3: Vanguard Dividend Appreciation ETF (VIG)
1-Year Performance: 16.8%
5-Year Performance: 19.2% (annualized)
Expense Ratio: 0.1%
If your investment emphasis is more oriented toward quality, then one of the best index funds to achieve that objective is the Vanguard Dividend Appreciation ETF (VIG).
This fund is pegged to the Nasdaq US Dividend Achievers Select Index, which is a collection of companies with a demonstrated record of increasing dividend payouts over time. We are talking about stalwarts such as Abbott Laboratories (ABT), PepsiCo (PEP) and Procter & Gamble (PG), to name just a few.
The name in a way belies the true strength of VIG. While Vanguard Dividend Appreciation does in fact go after dividend stocks, its focus on companies that increase their payouts still only results in a fund yielding 1.9%. However, it also results in holdings that reflect long-term quality and stability — and that’s the advantage you’re truly gaining in VIG.
Best Index Funds #4: iShares Russell 2000 Index ETF (IWM)
1-Year Performance: 26.5%
5-Year Performance: 25.7% (annualized)
Expense Ratio: 0.25%
If you want to be a bit more aggressive with your selections (and I do), then one of the best index funds to own is the iShares Russell 2000 Index ETF (IWM).
The IWM is a proxy for the small-cap segment of the U.S. equity market — a segment that tends to be more volatile than its large-cap brethren; however, these stocks also tend to provide bigger gains during bullish times. And, if you have a very long, Warren Buffett-style time horizon, you most likely can weather the occasional bear slumps.
Best Index Funds #5: Vanguard Short-Term Bond ETF (BSV)
1-Year Performance: 0.64%
5-Year Performance: 13.2% (annualized)
Expense Ratio: 0.1%
If you’re strictly following the Warren Buffett model, you will need to have a fund to park some cash and offer a bit of diversification to your holdings. One of the best index funds to do just that is the Vanguard Short-Term Bond ETF (BSV).
This ETF is pegged to the Barclays U.S. 1-5 Year Government/Credit Float Adjusted Index, which includes all medium- and large-issue government, investment-grade corporate and investment-grade international dollar-denominated bonds with maturities between one and five years.
The short-term segment of the bond market is essentially a way to shield your money from volatility and risk, and that makes it a good choice for ready reserve cash.
As of this writing, Jim Woods was long VTI and IWM.